The Influence of Guanxi on the Fund Manager-Analyst Relationship

Financial analysts are important information intermediaries who provide useful market information and insights into financial data for identifying opportunities, ultimately influencing investors’ decisions.

Fund managers rely particularly heavily on financial analysts for information. This is because they need to have an information advantage over other investors in order to achieve superior returns for their portfolios. If the information to be obtained is of an internal or sensitive nature, it is imperative for fund managers to have strong mutual trust with analysts, and this trust is often built on social ties.

In markets where the legal system is deficient and law enforcement weak, social connections between fund managers and analysts play an especially important role in facilitating the transmission of information. In China, where the rule of law is incomplete and guanxi dynamics play a major role in economic activities, how are interactions between fund managers and sell-side analysts influenced by their guanxi ties? How do such connections affect their business decisions? What are the potential benefits and costs of such ties to the market? We sought to answer these questions in the paper Friends in Need Are Friends Indeed: An Analysis of Social Ties Between Financial Analysts and Mutual Fund Managers.

“There are both potential benefits and costs to the market arising from fund manager-analyst guanxi ties. On the plus side, they encourage discovery and transmission of information, thus leading to more efficient pricing. On the other hand, guanxi connections can facilitate collusion between fund managers and analysts.”

Prof. George Yang

By analysing the behaviours of fund managers and analysts with college, workplace and hometown connections, we found that fund managers are more likely to obtain more support from analysts with whom they have guanxi ties, more likely to hold stocks covered by those analysts, and make higher abnormal returns from the connected holdings.

To reciprocate the benefits received from their connected analysts, fund managers are more likely to vote in favour of the analysts in star analyst elections, and fund companies are more inclined to allocate trading commissions to their brokerages whose analysts have guanxi with the fund companies’ fund managers. We also found that analysts may return favours to their connected fund managers by actively collecting information and writing more optimistically biased reports on stocks held by the fund managers.

Guanxi connections are invisible. It is especially difficult for small investors to detect them. Yet such connections can have a considerable impact on the behaviours of fund managers and analysts, especially in a market like China where transactions of firms often fall in the grey area of law and public disclosure is out of question. In such an environment, analysts have to resort to informal, private channels to access information on these firms. They will then pass the information to fund managers they trust. As for fund managers, they may not easily act on a piece of information unless it comes from analysts they trust.

There are both potential benefits and costs to the market arising from fund manager-analyst guanxi ties. On the plus side, they encourage discovery and transmission of information, thus leading to more efficient pricing. On the other hand, guanxi connections can facilitate collusion between fund managers and analysts. Consequently, the public can be on the receiving end of distorted research opinions.

To find out more about a specific topic, click on the links below to navigate to the relevant chapter:

INTRODUCTION – Where Guanxi Matters: The Modern Chinese Financial Sector

PART I – The Influence of Guanxi on the Fund Manager-Analyst Relationship

PART II – Does Guanxi Affect the IPO Process in China?

PART III – Guanxi and Auditing

PART IV – Can Guanxi Help Analysts to Uncover Bad News?

CONCLUSION – How to Counter Negative Effects of Guanxi Ties in Financial Sector?

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